10/28/2009
McKinsey: What Matters: Global sourci…
Su bscr ibe: E-m ai l | RSS
Prev i ou s: Getti n g h istory r igh t
N ext: How execu ti v es v i ew gl obal i zati on
Global sourcing in a world less flat
By Dan Braga, Drew Erdmann, Y ogesh Malik, and Aurobind Satpathy
2 1 April 2 009
John Maynard Keynes, the great British economist, is suddenly back in vogue. During
the current global economic downturn, you hear his name invoked in discussions
regarding stimulus packages in the United States, China, Europe, and elsewhere aimed
at preventing a 21st century Great Depression.
But Keynes also speaks to those contemplating the potential patterns of global sourcing
and trade in the coming decades. In writing The Economic Consequences of the Peace
in 1919, he considered the state of globalization on the eve of the First World War:
The inhabitant of London [in August 1914] could order by telephone, sipping his
morning tea in bed, the various products of the whole earth, in such quantity as he
might see fit, and reasonably expect their early delivery upon his doorstep; he could at
the same moment and by the same means adventure his wealth in the natural
resources and new enterprises of any quarter of the world, and share, without exertion
or even trouble, in their prospective fruits and advantages; or he could decide to couple
the security of his fortunes with the good faith of the townspeople of any substantial
municipality in any continent that fancy or information might recommend…. But,
most important of all, he regarded this state of affairs as normal, certain, and
permanent, except in the direction of further improvement, and any deviation from it
as aberrant, scandalous, and avoidable.
Sound eerily familiar? Almost like the world had been flattened before.
So Keynes reminds us of three basic lessons. First, globalization is not new. Second, the
fabric of globalization is woven equally from the warp of politics within and among
countries and the weft of individual business decisions. Third, globalization’s progress is
not inevitable. As Keynes and members of his generation who survived the First World
War knew well, globalization can be fragile indeed.
The current global downturn has laid bare the simplistic assumptions under many a
global sourcing strategy, as Keynes could have anticipated. A misguided sense of
security and predictability began to permeate sourcing decisions during the past two
decades. International trade exploded, driven in part by the opening of previously
closed markets in both Asia and Eastern Europe. Sourcing from so-called low-cost
countries blossomed. China emerged as an economic powerhouse and supplier of
…mckinseydigital.com/…/global-sourcin…
1/5
10/28/2009
McKinsey: What Matters: Global sourci…
choice in many sectors. Progress and prosperity appeared inexorable. Echoing Keynes’
man of London of 1914, many at the start of the 21st century “regarded this state of
affairs as normal, certain, and permanent,” and bet their sourcing strategies on it.
Then came, in short order, financial contagion, the bust of the commodity boom, the
collapse of international trade, and the worst global economic downturn since the
Great Depression. The new uncertainties can bewilder. Consider recent headlines on the
future costs of sea transportation and their implications: in the summer of 2008 The
Wall Street Journal and The New York Times both suggested high transportation costs
might soon make Asian sourcing prohibitively expensive in many industries, and then
in January 2009 the Journal noted without irony that containers are moving virtually
free of charge in a sea of shipping overcapacity. Tracking the headlines leads to
confusion, not clarity, in thinking about an enduring strategy.
So how can we navigate global sourcing opportunities and risks in the face of this
uncertainty?
We at McKinsey undertook a major research effort, tapping our global network and
cross-industry expertise to answer this question.1 Only charlatans or fools would
pretend to predict the exact contours of the global sourcing landscape 3 to 5 years
hence, let alone 20 years. However, organizations can and should confront the
uncertainties head-on in a rigorous, fact-based way, rather than trying to wish them
away. Deep understanding of global forces and scenario-based analysis provides a more
realistic approach to test potential sourcing strategies than betting on a single view of
the future. While there are many potential industry-specific subtleties that can be
teased out using this approach, three major themes emerge.
First, the underlying logic driving global sourcing will endure despite the recent
economic turbulence. Whatever the scenario, global sourcing makes sense as long as
low-cost countries remain. And there is no reason to believe that significant gaps
among countries will disappear. Take labor costs: while Chinese labor costs have been
closing in on US costs in percentage terms since the mid-1990s, the gap in absolute
terms between Chinese and US manufacturing labor costs per hour is projected to
increase to more than $26.00 in 2013, from roughly $17.50 in 1996. Regional
variations in material inputs (such as steel) also place offshore sourcing at an
advantage in many categories. And we should expect the expansion and increasing
sophistication of supplier networks in the major developing countries – such as China,
India, and Brazil – that will account for the majority of global economic growth and
new consumers in the coming decades. At the same time, balancing out basic price
considerations, time-to-market considerations (for example, customized products with
short lead times, such as some high-tech items), sensitivities to transportation costs
(automobile assembly, for instance), and other factors will keep some level of
production close to the consumer.
…mckinseydigital.com/…/global-sourcin…
2/5
10/28/2009
McKinsey: What Matters: Global sourci…
Second, relative cost advantages are dynamic, not static. We should not be surprised to
see intensifying competition within low-cost countries, as regions vie to attract
investment and jobs. Again, consider labor costs. Just as there can be significant cost
differences between, say, factories in Michigan and Alabama in the United States,
China is hardly monolithic: we already see significant variations between labor costs
between Shanghai and the interior; likewise in India. States will compete with each
other for business. At the same time, companies will find intensifying competition for
their business between low-cost countries. In the lead-up to the current crisis, the
Chinese economy’s steady growth helped fuel wage inflation that has in turn given
other Asian “ultra” low-cost countries a potential edge. For example, in 1997 labor costs
were roughly equal between China and Vietnam; a decade later, a Chinese
manufacturing worker cost nearly three times as much as his or her Vietnamese
counterpart. The impact of such changes is not theoretical. In 2009, for instance, Nike
expects to make more shoes in Vietnam than China for the first time in its history.
Third, politics will matter—a lot—to the future of global sourcing. They always have, of
course, but the relative stability of the late 1990s and early 2000s masked this reality.
Looking to the future, public policies will influence the trajectory and pace of change
across many variables commonly viewed as simply “economic.” For instance, the
Chinese government is not standing idly by in the face of trends that are eroding
Chinese competitiveness. While the Chinese government seeks to devise policies to
rebalance its economy toward more domestic consumption, value-added tax rebates,
industrial subsidies, and currency policy support exporters. The Chinese government
can pull all these levers and more to flip the best case economics back in China’s favor
for strategic industries. But every country can play that game—and they are.
Whether or not countries will agree to play by common rules in international trade or
pursue their own nationalist or regional policies will be critical. Today, the picture in
overall trade policy remains mixed. World Trade Organization membership grew and
average tariff rates fell between 1988 and 2007. Businesses are more interconnected
than ever before. Even before the onset of the current crisis, however, there were signs
that that global commitment to an open international trading order was eroding. The
WTO’s Doha Development Round of trade talks have been on life support for years.
Since 1995 the number of regional trade deals—which are inherently discriminatory—
has increased over three fold. Equally troubling for an open international trading
system, BBC World Service polling revealed that majorities in eight of the top ten
economies, including the United States, thought that globalization was moving too fast
for their tastes by January 2008.
In the current economic crisis, most countries have not yet succumbed to the
temptation of significant beggar-thy-neighbor protectionism. But if the downturn
broadens and deepens, politicians may not be able to resist the potential short-term
political appeal of economic nationalism or regionalism. Last November, the ink had
barely dried on G-20 2 leaders’ statement committing themselves to fight protectionism
…mckinseydigital.com/…/global-sourcin…
3/5
10/28/2009
McKinsey: What Matters: Global sourci…
before protectionism’s creep resumed. According to the World Bank, 17 of the G-20
have implemented protectionist measures in the three months following the
Washington, DC, summit. So far the wealthier countries have resorted to subsidies—
think of the automobile industries in Argentina, Brazil, Canada, France, Germany,
United Kingdom, the United States, and others—while developing countries tend to
erect trade barriers. Security, safety, and environmental regulations could become new
forms of protectionism.
We will not hazard to predict whether during the coming decades globalization will
resume, regionalism will rise, or extreme economic nationalism will triumph. But we
are confident that the companies most likely to survive and thrive in the coming years
will have internalized Keynes’ foundational insight that their global sourcing strategy
must adapt to a complex interplay of forces, both economic and political. As
competition heats up among low-cost countries within and among regions, successful
companies will develop a deeper understanding of the global forces influencing their
sourcing economics, thereby allowing them to anticipate potential “flips” among
optimal sourcing locations. In the coming years, executives will need to understand the
nuances of the local politics in their critical sourcing countries—for instance, state
politics in India—as much as they do their own home states. With investment in the
knowledge of local politics and suppliers, companies will be able to lobby and persuade
to shape their business environments in other countries. Others may diversify their
sourcing portfolios across regions—say, China and Mexico—to hedge against potential
shifts in transportation, critical input, and tariff costs. Some US companies may
conclude the uncertainties facing their industries are too great and thus decide to
minimize risk by moving some sourcing categories back from Asia to within NAFTA 3
and DR-CAFTA 4 or even onshore again. Organizations will recruit, train, and retain
different talent to navigate these sourcing decisions, or be left behind.
Whatever the future may bring, the ability to understand global forces at play and
employ fact-based analysis that envisions a range of scenarios will provide competitive
advantage over those organizations that continue to deny the uncertainties and plan
for only one “possible future.”
1
Contributors to the development of and analysis informing this study include Stacey Galvez and Sunil
Manhapra, both consultants in McKinsey’s Chicago office.
2
The G-20 member countries are: Argentina, Australia, Brazil, Canada, China, the European Union,
France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea,
Turkey, the United Kingdom, and the United States.
3
North American Free Trade Agreement.
4
Dominican Republic–Central America Free Trade Agreement.
Back to top
Prev i ou s: Getti n g h istory r igh t
…mckinseydigital.com/…/global-sourcin…
4/5
10/28/2009
McKinsey: What Matters: Global sourci…
N ext: How execu ti v es v i ew gl obal i zati on
Hom e | Contact | Term s | Priv acy | © Copy right 2 009 McKinsey & Com pany | McKinsey Quarterly
…mckinseydigital.com/…/global-sourcin…
5/5